Obtaining a loan for your small business is a great way to cover important costs or grow your business when the time is right. You might have heard some grumblings about small business loans: They’re hard to obtain; your credit has to be flawless; don’t ask for too much money or you’ll be denied. Fortunately, these prevalent ideas surrounding small business lending aren’t necessarily true.
It’s important to manage debt properly, but doing so can help grow your business at a faster rate than scrimping and saving. To help you obtain a small business loan for your company, Business News Daily spoke with finance experts to answer nine small business loan FAQs.
No. Like other forms of financing, obtaining a small business loan is all about preparation. Ensuring your books are transparent and you maintain the reserve liquidity to encourage the lender that you’ll be able to service your debt consistently on time will lead to success. And experts agree the best way to avoid unnecessary snags is to prepare for the application process.
“A lot of the frustration around obtaining small business financing can be eased by doing your due diligence,” said Michael Adam, founder and CEO of Bankmybiz, a site that connects business owners with business funders. “Be prepared, and have all your documents ready to present to lenders.” [Read related article: Small Business Financing Trends]
Obtaining small business financing doesn’t have to be an uphill battle. Prepare your documentation, and ensure you come ready to make your case for why this loan will generate a return on investment.
No. A low credit score is a concern for some lenders, but banks aren’t the only lenders out there. In fact, it’s far from impossible to get a business loan with bad credit. Alternative and private lenders are often able to offer more flexible terms, including which level of creditworthiness they can approve.
“While traditional banks may be restrictive when it comes to obtaining credit, there are alternative options,” said Michael Kevitch, founder of Small Business Funding.
Alternative lending sites such as Small Business Funding tend to base lending decisions on the financial realities of a business rather than the financial history of business owners. Specifically, Kevitch said, alternative lenders take a close look at business performance, industry type, time in business and cash flow before handing out a loan.
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Not always. Entrepreneurs have more than one option for obtaining financing; banks are not the only game in town. There are alternative and private lenders, as well as creative types of lending like invoice factoring, which can help business owners shore up their capital without going through the lengthy and restrictive application process required by conventional lenders.
For business owners looking to borrow a relatively small sum (between $5,000 and $250,000), getting a bank loan is likely to be more trouble than it’s worth, Kevitch said. Banks are more suitable for businesses that are interested in borrowing a large amount of cash and repaying the loan over a long period of time at a relatively low interest rate. Kevitch advised business owners to make sure they fall under those categories before applying through a bank.
Instead, Kevitch said, alternative lending sources often provide faster approvals for shorter loan repayment periods; sometimes businesses can obtain access to the funds in as little as seven days, he said. Because the terms are more flexible, interest rates are often higher.
There is no “worst” type of financing; it depends on your business’s circumstances and your ability to reliably service any debt you take on. Just because you can obtain financing elsewhere doesn’t mean conventional lenders and bank loans are not for you.
Sometimes, a bank offers exactly the funding option you need. In fact, for established businesses looking to grow at a moderate rate, traditional bank funding is generally a great option, Adam said. It’s when a business doesn’t fit those criteria that business owners should consider shopping around.
“If you are a younger company, pre-revenue or low revenue, but plan to grow very quickly due to the industry that you’re in – e.g., healthcare, IT or software consulting – then a traditional bank loan may actually limit your growth,” Adam said.
To decide whether a bank loan is right for your business, research both traditional loans and alternative funding sources. It’s also important to know your business inside and out.
“If you anticipate steady growth over the next few years, then a traditional bank may be best,” Adam said. “If you are growing like crazy and you know you will need to keep increasing your loan size by large increments each quarter, then entertain a nonbank lending partner, as banks may not be able to keep up with your needs.”
No, the requested principal amount of the loan should not have an adverse impact on whether or not you get approved. Lending institutions are generally prepared to fulfill large financing requests for the right borrower; it’s more lucrative for them in the long run anyway. Don’t be afraid to ask for the amount of money that you really need!
According to Jess Harris, content and social manager of business lender Kabbage, banks prefer lending larger amounts because they make more profit from large loans in the long run. In turn, banks are cutting back on smaller loans.
Evan Singer, president and CEO of online Small Business Administration loan program SmartBiz Loans, said a business should apply for the amount it needs – no more and no less. He recommends considering both how much money you really need to grow your business and how much money you can afford to pay back every month.
“Make sure that you have cash flow to make your loan payments,” Singer said. “That’s the biggest thing that a [lender] is going to check – that [the business owner] can actually afford to make their loan payments.”
Apply only for the amount of funding your small business needs – no more, no less.
It’s easy to put too much emphasis on the interest rate of the loan. Essentially, the interest rate determines just how much the loan is going to cost by the end of the repayment period. It’s certainly a crucial piece of information, but it’s just one aspect of the entire deal.
Although the interest rate is an important aspect to consider when choosing a lender, there are many other factors to keep in mind. Harris suggested asking what the terms of the loan are, how soon you need to repay the money and what you can use the loan for.
The first step when trying to get a business loan is gathering everything you need to apply. These needs include tangible items and process considerations, such as the following:
Although there’s no objective answer to this question, you could argue that small business loans are a top option. After all, they’re so frequently used for a reason: If you appropriately plan for them, you can budget for monthly payments fairly easily. On the other hand, you might prefer angel investors or venture capitalists, since they might not ask you to repay them if your business fails. But you do give up quite a bit of business control and equity to work with these investors.
You can also turn to loans from friends and family, credit cards, crowdfunding, or business lines of credit. Each of these options has its pros and cons. For example, think about what could happen in your personal life if you fail to repay a loved one. Credit options have problems, too: They may come with high fees that make them untenable. Crowdfunding also doesn’t guarantee that you’ll reach your desired funding level.
The answer to this depends almost entirely on your loan term. A loan with a five-year term should take that long to repay. That said, if you can pay your loan off early, that’s a good thing, as long as you don’t incur a prepayment fee for doing so. If there is a fee, you might want to hold on to that loan a bit longer. Your monthly expenses might be less than the potential fee.
Max Freedman, Sammi Caramela, and Elizabeth Peterson contributed to the writing and reporting in this article. Source interviews were conducted for a previous version of this article.